A 'disorderly' default in Europe is now a possibility and holds grave dangers for the Singapore economy, the government warned yesterday.

The increased risk that the European crisis will spin out of control is a key reason the Trade and Industry Ministry (MTI) is sticking to its growth forecast of between 1 and 3 per cent this year, despite positive signals from the economy in recent months.

The economy expanded by 1.6 per cent in the first quarter compared with the same period a year ago, driven by construction and services.

But while economic activity picked up in the first quarter, the MTI said the outlook for the rest of the year is cloudy as recovery in the global economy remains fragile and vulnerable.

The recovery in the United States, which seemed to be picking up earlier in the year, has started to lose steam and China's growth prospects have also fallen.

But the biggest risk is in Europe, where fears of Greece defaulting on its loans have sparked turmoil in financial markets.

MTI permanent secretary Ow Foong Pheng told a briefing yesterday that changes in the political landscape in the region "endanger promised reforms and crisis measures".

The French have a new President while the Greeks will head to the polls next month after elections on May 6 failed to deliver a government.

"The high level of uncertainty surrounding the euro zone's political climate and fiscal outlook will continue to weigh on the global economy. This will in turn dampen growth in Singapore's externally oriented sectors," said Ow.

The MTI added that a "disorderly" default by euro zone members "cannot be ruled out at this stage". "If it materialises, there will be considerable downside for the global economy and Singapore's externally oriented industries," it said.

A disorderly default occurs when a country such as Greece does not pay its creditors on time.

"This then leads to investors dumping bonds of other European countries, such as Portugal and Italy. The fear is really over contagion," said OCBC economist Selena Ling.

The MTI's warnings came despite first-quarter gross domestic product (GDP) figures which show that the economy, especially the domestic sectors, continued to show resilience.

Construction was the main driver of growth for the three months to March 31, growing 7.7 per cent over the same period last year. Services expanded 2.2 per cent, but manufacturing fell 1 per cent compared with last year.

Compared with the last three months of 2011, the economy actually grew by 10 per cent, suggesting that the pace of growth has picked up.

Non-oil domestic exports in April were up a surprisingly high 8.3 per cent, lifted by pharmaceuticals, which surged 38.4 per cent.

Barclays economist Leong Wai Ho noted that the MTI composite leading index, a forward-looking indicator of the health of the economy, rose 2.9 per cent.

"We believe growth has bottomed out and expect the economy to expand 4 per cent for the whole of 2012," he said.

But Credit Suisse economist Robert Prior-Wandesforde said the strong export figures are largely due to exporters' belief in a "false dawn".

He pointed out that exports to Europe and the US continued to fall in double-digit figures and that the bulk of growth of pharmaceutical exports last month stemmed from a 124 per cent increase in drug exports to Japan compared with last year. If the Japan export numbers were stripped out, export growth was just 1.1 per cent.

"It looks to us that output overshot orders in the first couple of months of the year, perhaps reflecting renewed optimism about the US and euro zone economies," Prior-Wandesforde added.